FASB Information For CFMs

April 10, 2013At FASB’s April 10 board meeting, members voted 4-3 to move forward with a revised exposure draft on lease accounting. FASB’s revised exposure draft will also converge with the International Accounting Standards Board’s (IASB) lease proposal and achieve its key objective of requiring all leases, other than short-term leases, to be recognized on the balance sheet. The proposal establishes a dual-model income statement recognition approach whereby determining which model to apply will depend on the level of consumption of the underlying asset during the lease period.

“Many people think that there should be one model here,” FASB Chair Leslie Seidman said. “That is not universal. But they do not agree about which model. So we’ve done our best to try and articulate a distinction that reflects what some perceive as the economics of the difference between what I’ll call ‘rentals’ and what I’ll call ‘finance-type leases.’ ”

The leases project has been on the radar of various constituents because of its breadth and the extent to which leases are used. FASB’s and IASB’s converged standard could bring significant global comparability to financial statements.

The FASB plans to release its exposure draft in mid-May and the IASB plans to release its exposure draft by June 30.

July 31, 2012The FASB yesterday issued an Invitation to Comment on a staff paper that outlines an approach for deciding whether and when to modify U.S. GAAP for private companies. The paper, Private Company Decision-Making Framework: A Framework for Evaluating Financial Accounting and Reporting Guidance for Private Companies, contains initial FASB staff recommendations for criteria to determine whether and in what circumstances it is appropriate to adjust financial reporting requirements for private companies following U.S. GAAP.

“The development of a sound decision-making framework is essential to our ongoing efforts to address the unique needs of private company stakeholders while maintaining the high quality of U.S. GAAP,” FASB Chairman Leslie Seidman said. “We anticipate that the guidance designed to identify cost-effective alternatives for private companies also will benefit some of the FASB's public and not-for-profit standard-setting activities.” The deadline for comments is October 31.(pdf)

July 12, 2012The Financial Accounting Standards Board (FASB) issued the Invitation to Comment, Disclosure Framework, to ask for stakeholder input on ways to improve effectiveness of disclosures in notes to financial statements of public, private, and not-for-profit organizations. The Invitation to Comment is the FASB’s first step in soliciting broad input on ways to improve disclosure effectiveness. The Invitation to Comment addresses the following topics:

A decision process that could aid the Board in establishing disclosure requirements that address relevant information and only relevant information.

Flexible disclosure requirements that could be adapted by each reporting organization to focus on information that is relevant in its specific circumstances.

A judgment framework that could help each reporting organization determine which disclosures are relevant in its specific circumstances.

Organization and formatting techniques that could make the information users need easier to find and understand.

April 23, 2012On Thursday, April 26 9AM-12Noon and 1-4pm ET FASB and IASB will hold a public roundtable meeting on Revenue Recognition. The audio of these meetings are available via webcast through the FASB website. The Boards’ purpose in holding the meetings is to engage in a constructive dialogue about the proposal with a wide variety of stakeholders. To ensure the Boards receive broad-based input, meeting participants will represent a wide variety of perspectives, including those of preparers, auditors, investors, and other users of financial statements.

March 5, 2012FASB/IASB held an update conference call on February 29. Jerry Henderson, chairman of CFMA’s Emerging Issues Committee attended. Click here for his notes from the call.

January 27, 2012On December 21, 2011, the CFMA Webinar Series hosted a webcast led by Emerging Issues Chairman, Jerry Henderson, on the Revenue Recognition re-exposure draft. To view the archive of this session Click here.

Click here to view our article on Revenue Recognition: Exposure Draft Revised in the November/December 2011 issue of CFMA Building Profits. (Note: You will need to enter your CFMA login to access this article)

December 5, 2011Revenue Recognition Exposure Draft Revised: What CFMs Need to Knowby Jerry Henderson and Mike Sobolewski On November 14, 2011, FASB and IASB issued their Revised Exposure Draft on Revenue Recognition. Once finalized, it will replace most existing revenue recognition and construction cost accounting guidance under U.S. GAAP and IFRS. Click here for a summary of the most significant changes from the original Exposure Draft that will impact the construction industry.br> November 16, 2011FASB Revenue Recognition exposure draft has been re-released.Click here to read and download the exposure draft.

As a result of outreach to external stakeholders, study, and deliberation, the Financial Accounting Foundation (FAF) Board of Trustees plans to establish a “Private Company Standards Improvement Council” (PCSIC) to improve the standard-setting process for private companies. The Trustees seek public comment on the plan, as outlined in this document, until January 14, 2012. The Trustees will make a final decision on the plan following the end of the comment period. Click here to read more. Revenue Recognition Update: The Revenue Recognition Re-Exposure Draft is expected to be released this fall. CFMA will provide more information once this Re-Exposure Draft is released.

Last year, the FASB issued an exposure draft that would require expanded disclosure requirements for participants in a multiemployer pension plan.

July 27, 2011“It was expected that the FASB would remove the proposed requirement to disclose withdrawal liability. However, it was a pleasant surprise to see the requirement for disclosing an estimate of underfunded liability removed.”Steve Lords, CFO, Martin-Harris Construction, Las Vegas, NVMember of FASB Private Company Financial Reporting Committee

Multiemployer pension plans commonly are used by an employer to provide benefits to union employees who may work for many employers during their working life, thereby enabling them to accrue benefits in a single pension plan for their retirement.

“Historically, very limited information about these plans has been disclosed, even though they may represent significant potential obligations for many large, unionized industries such as trucking, supermarket chains, and construction firms,” said FASB Chairman Leslie F. Seidman.

“The enhanced disclosures will ensure that shareholders in companies that participate in these plans, workers who depend on them for their retirement benefits, as well as lenders and others, will have more information regarding the employers’ pension commitments and the financial health of the plans.”

Prior to today’s action by the FASB, employers were required to disclose only their total contributions to all multiemployer plans in which they participate.

Today’s decisions conclude comprehensive deliberations about the disclosures an employer should provide. The FASB issued initial proposals for revising disclosures for public comment in September 2010.

As part of its redeliberations, the FASB decided to delete a proposal to require employers to disclose their withdrawal liability to all plans in which they participate, or provide a “point-in-time” estimate of its obligations with respect to the underfunded status of individual plans.

Many of those who commented on the FASB’s proposal on multiemployer plans told the Board that the withdrawal liability would not be an appropriate proxy for an employer’s proportional share of the underfunded status of the plan. They suggested that the employer’s share of the underfunded status of the plan can only be determined through the collective bargaining process and they urged the FASB not to require a “point-in-time” estimate of an employer’s obligations with respect to underfunding.

Pursuant to the FASB’s decisions, the new disclosures will include:

The amount of employer contributions made to each significant plan and to all plans in the aggregate.

An indication of whether the employer’s contributions represent more than five percent of total contributions to the plan.

An indication of which plans, if any, are subject to a funding improvement plan.

The expiration date(s) of collective bargaining agreement(s) and any minimum funding arrangements.

The most recent certified funded status of the plan, as determined by the plan’s so-called “zone status,” which is required by the Pension Protection Act of 2006. If the “zone status” is not available, an employer will be required to disclose whether the plan is:

Less than 65 percent funded

Between 65 percent and 80 percent funded

Greater than 80 percent funded.

A description of the nature and effect of any changes affecting comparability for each period in which a statement of income is presented.

The FASB expects that the revisions approved today will be finalized in September 2011. For public entities, the enhanced disclosures will be required in fiscal years ending after December 15, 2011. For nonpublic entities, the enhanced disclosures will be required in fiscal years ending after December 15, 2012.

June 15, 2011IASB and FASB to re-expose revenue recognition proposalsThe International Accounting Standards Board (IASB) and the US-based FinancialAccounting Standards Board (FASB) agreed today to re-expose their revised proposals for a common revenue recognition standard. Re-exposing the revised proposals will provide interested parties with an opportunity to comment on revisions the boards have undertaken since the publication of an exposure draft on revenue recognition in June 2010.

It was the unanimous view of the boards that while there was no formal due process requirement to re-expose the proposals it was appropriate to go beyond established due process given the importance of the revenue number to all companies and the need to take all possible steps to avoid unintended consequences.

Consequently, the boards intend to re-expose their work in the third quarter of 2011 for a comment period of 120 days.

Commenting on the decision, Sir David Tweedie, Chairman of the IASB said: “It is important that we get this right, first time. That is why the boards and staff have undertaken an unprecedented level of outreach to get us to this point, and why we are keen to treble-check that our conclusions are robust and can be implemented with minimal disruption.”

Leslie Seidman, Chairman of the FASB, said: “Given the prominent role of revenue in financial statement analysis, the boards decided that it would be appropriate to re-expose the proposed standard, and afford our stakeholders the opportunity to review the changes in context.”

Also, be sure to read “Lease Accounting Update for Contractors” by Shane Brown and Chris Banks in the November/December issue of CFMA Building Profits for details on the proposed changes and their impact on the construction industry.

The issuance of this Exposure Draft follows approximately 18 months of evaluation and input received following the issuance of the similarly titled Discussion Paper, Preliminary Views on Revenue Recognition in Contracts with Customers. To read CFMA’s letter in response to the Discussion Paper, click here.

At present, construction contractors generally follow the guidance contained in ASC 605-35 (formerly known as SOP 81-1); however, if the provisions of this Exposure Draft are adopted, these changes could have a significant and undesirable impact on the financial statements of contractors.

For this reason, we are encouraging contractors, CPAs in practice, and in particular, users of financial statements (such as sureties and lenders) to learn about and understand the proposed changes; and then, to help us take action by responding to FASB with our thoughts on the proposed Exposure Draft.|

Key Changes Affecting Contractors

With very limited exceptions, the economic unit of measure in ASC 605-35 is the entire contract, which means the contract is not further subdivided for the purpose of determining how revenue should be recognized. In addition, change orders are treated as adjustments to the original contract as opposed to treating them as separate economic units. The Exposure Draft contains potentially significant revisions to this approach, as discussed below.

ASC 605-35 presumes ratable revenue recognition during the entire construction period. While the Exposure Draft permits ratable recognition of revenue, the contractor must demonstrate it meets specific criteria to qualify for ratable recognition of revenue. In practice, most contracts will continue to qualify for ratable revenue recognition, but some will not.

Another significant difference between ASC 605-35 and the Exposure Draft is the decoupling of contract costs from contract revenues. Under ASC 605-35, most contractors use “costs incurred” to measure revenue, hence the recognition of revenue is aligned with costs. By contrast, in the Exposure Draft, revenue is recognized as “performance obligations” are satisfied, which in some cases will not be tied to costs incurred; hence, the decoupling of contract costs and contract revenues.

To compensate for the decoupling of costs and revenues, the Exposure Draft prescribes new cost capitalization rules. In general, this will be important when contractors are incurring precontract costs, but have not yet satisfied a performance obligation.

Because the performance obligation becomes the economic unit of measure, if a contractor anticipates a loss in fulfilling a performance obligation, that estimated loss is accrued as soon as it is identified – even if there may be substantial estimated profit in the fulfillment of other performance obligations.Finally, the Exposure Draft prescribes new disclosure requirements to assist financial statement users in understanding revenue recognition transactions (e.g., the reporting entity must provide a reconciliation of changes in net open contract positions from the last reporting date to the current reporting date).

Economic Unit of Measure

As previously noted, in most cases, the economic unit of measure in ASC 605-35 is the entire contract as adjusted from time to time for change orders. However, the Exposure Draft requires that contracts must be separated into various performance obligations; guidance is provided to help illustrate how this might work. For example, a design/build general contractor would generally separate the project’s design aspects and its building aspects into at least two separate performance obligations.

Once performance obligations in the contract are identified, the contract price is allocated among the various performance obligations based upon either a known or estimated standalone selling price for each service. Since almost every construction contract is unique, considerable judgment will be required in both identifying performance obligations in the contract and in allocating the contract price among various performance obligations. Likewise, change orders will have to be evaluated to determine whether a change order is a change to an existing performance obligation within the contract or if it constitutes a new performance obligation altogether.

While these changes may not sound alarming at first reading, company owners and construction financial professionals will have enhanced opportunities to break up their contracts into various performance obligations and place the revenue into those parts of the contract where they want to see the most profit – and, the highly subjective nature of the standard will make it difficult to challenge these judgments. This has the potential to lead to earnings management, and ultimately, to undermine the credibility in financial reporting that exists today.

We believe that this will result in sureties and lenders wanting to see contracts re-aggregated into a single economic unit of measure. This is why input is so important, particularly from the financial statement user community.

Qualifying for Ratable Revenue Recognition

The Exposure Draft contains a concept referred to as “continuous transfer of goods or services.” Several criteria are defined to help reporting entities determine whether the contract provides for a continuous transfer of goods or services—and hence, ratable revenue recognition.

When a customer initiates a project and directs the hiring of the contractor (even if through a representative, such as an architect), then there is a strong likelihood the contract will meet the continuous transfer criteria. Alternatively, if the contractor acts as the project developer (e.g., in the building of condominiums), then it is less likely the project will meet the continuous transfer criteria, and revenue recognition would be deferred until the customer has obtained ultimate control of the project.

In situations where a continuous transfer is deemed to exist, then the contractor will recognize revenue ratably for that performance obligation using either an input or output measure. Input measures can include items like labor hours or costs incurred. Accordingly, within each performance obligation, the contractor can continue to report revenue in a manner consistent with the current percentage-of-completion method.

Cost Capitalization

Under the Exposure Draft, new cost capitalization rules have been incorporated at the behest of construction industry constituents since costs have been divorced from revenues. The importance of these rules can be most clearly seen in the early stages of a contract (e.g., when a contractor may be incurring mobilization costs, which by definition are not related to the fulfillment of a specific performance obligation). Absent the cost capitalization rules, contractors might experience a negative profit margin in the early stages of many contracts.

Costs incurred in procuring the contract are not eligible for capitalization, while costs incurred in fulfilling the contract are eligible for capitalization. Costs may be incurred during the procurement phase that also relate to fulfillment, such as certain design costs. So long as those costs are integral to the fulfillment of the contract, they may be capitalized, but only for contracts actually awarded to the contractor.

Once costs are capitalized, they should be derecognized in a rational manner as performance obligations are fulfilled—in this case, generally, revenues will be matched against costs.

Anticipated Losses

Under ASC 605-35, anticipated losses on uncompleted contracts are accrued at the time they are identified. The Exposure Draft retains this guidance; however, anticipated losses will be accrued for each discrete performance obligation for which a loss is anticipated – even if a profit is anticipated for the overall contract. Decisions made after a contract has begun to incur additional costs in one phase, to save costs in a later phase, may inadvertently trigger the accrual of a loss even if the overall project becomes more profitable. Theoretically, this could occur; but, all relevant facts (including new cost capitalization rules) will need to be taken into account before presuming this will be the case.

Disclosure Requirements

FASB recognizes these changes will potentially be significant, particularly for the construction industry, so new disclosure guidance is included in the Exposure Draft to help enhance comparability and understanding by financial statement users. Reporting entities are required to disclose judgments used in determining the satisfaction of performance obligations, allocation of overall contract price to the specific performance obligations, methods used to recognize revenue when a continuous transfer is deemed to occur, how liabilities are measured when a loss is anticipated, and reconciliation of net open positions, as previously mentioned.

Conclusion

This Exposure Draft will substantially impact how contractors approach revenue recognition. FASB has not yet announced when these new rules will take effect; however, comments on the proposed rules are due by October 22, 2010.

CFMA will undertake outreach initiatives to educate members on the proposed rules, elicit feedback regarding the proposed rule, and organize a coordinated response from our membership group and other construction industry constituencies.

In the meantime, we encourage all General Members to begin considering how the new rules might impact their approach to revenue recognition and encourage Associate Members to evaluate how the new rules might impact their evaluation of revenue recognition, which is highly subjective.